Commonwealth Bank’s (ASX: CBA) fiscal 2026 profit increased 7% to a record AUD 11 billion. Loan growth of 7% and steady net interest margins more than offset 6% operating expense growth and a modest rise in loan impairment expenses.

Why it matters: The result is largely as expected. The bank is expanding at system in home loans and retail deposits, while taking share in business loans with the support of more bankers. However, competition in lending and deposits has eroded any hopes of a boost to NIM from higher cash rates. With mortgage applications down 15% since May—investors were unsurprisingly hit the hardest, down 28%—rate competition is expected to stay high. But with competitors earning below or modestly above the cost of equity we use in our valuations, we expect rational pricing to eventually prevail. While credit growth is expected to slow materially in fiscal 2027, we are positive on the long-term outlook. We expect average annual earnings growth of 5% over the next five years, driven by loan growth and cost savings. This drives a forecast ROE of 16% in fiscal 2030, compared with 14% this year.

The bottom line: We increase our fair value estimate for wide-moat Commonwealth Bank by 3% to AUD 108 due to the time value of money. Shares are materially overvalued, trading on a forward P/E ratio of around 26 and a dividend yield of 3%. We don’t think this is a case of it being priced for perfection; instead, we think the fundamentals no longer matter to the share price. We expect the bank to increase loans modestly ahead of the market, as its peers with much weaker ROE stop relying on cheaper rates to win market share, and as it benefits from additional investment in bankers and technology.

Key stats: Full-year fully franked dividends of AUD 5.05 slightly missed our AUD 5.10 forecast but are close to the top end of the bank’s 70%-80% payout target. We expect dividend growth to track earnings, supported by healthy provision levels and surplus capital.

Commonwealth Bank well-placed to navigate changes in economic conditions

Commonwealth Bank of Australia is the largest of Australia’s four highly profitable, wide-moat-rated major banks. It offers a full suite of banking services in Australia and New Zealand. In the long run, the bank has consistently increased shareholder wealth in favorable economic times. The loan book’s large weighting to home loans and the high proportion of customer deposits reduces risk on bad debts and sudden changes to funding costs.

While Australian housing is expensive and debt/household income ratios are high, we remain comfortable for several reasons. Tight underwriting standards, lender’s mortgage insurance, low average loan/valuation ratios, a high incidence of loan prepayment, full recourse lending, and a high proportion of variable rate home loans combine to mitigate potential losses from mortgage lending.

With cash rate increases to combat high inflation, the risk of higher credit losses has increased. It could also reduce demand for credit. Tax changes which restrict negative gearing and reduce capital gain tax discounts are also expected to be a headwind for mortgage growth. We expect modest credit growth and steady margins over the medium term. Operating expenses will continue to rise due to inflationary pressure and the bank investing to capture growth opportunities, this despite productivity improvements being realized.

Bad and doubtful debts expense peaked in first-half fiscal 2009. Elevated loan losses in fiscal 2020 were entirely due to loan loss provisions. With large provision balances, and economic conditions improving, loan losses are expected to be moderate in the short term.

A string of divestments plus strong organic capital generation see the bank retain a strong capital position even after completing share buybacks.

Bulls say

  • Commonwealth Bank of Australia’s well-managed net interest margins, sound asset quality, and strong balance sheet continue to consistently deliver solid financial results.
  • Costs have been increasing due to inflation and investments in technology, but in the longer term, we expect tighter control to support earnings.
  • Strong organic capital generation leave the bank well placed to make market share gains while still paying attractive dividends to shareholders.

Bears say

  • Increased regulatory, political and public scrutiny could erode the bank’s pricing power and over time, its wide economic moat.
  • Commonwealth Bank is a major beneficiary of transaction account funding, and competitors paying much higher rates could encourage more customer switching and increase the average cost of funds.
  • Slow GDP growth and highly indebted households could see credit growth slow further.

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